Why is 5,000 a Key Psychological Level?

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Damn you Dow Jones index flirting with 11,000!

If Australian stocks follow the overnight U.S. lead, they will fail to break through key psychological resistance levels and decline. In the U.S., the mental block investors have was compounded by U.S. Fed Chairman Ben Bernanke who, in a “dog bites man” kind of story, said that unemployment and rising home foreclosures would “challenge” the U.S. recovery.

Gold was up $15 on the day.

By the way, is that phrase “key psychological levels” just a load of horse pucky used by analysts and commentators to try and explain things they don’t understand? Why is 5,000 a key psychological level? Why not 5,031? Or 5,187? Or 42?

“The charts – especially the volume indicators and the moving averages – are an aggregate expression of people’s psychology and sentiment,” explained our resident trader Murray Dawes last week when we asked him about it. “It doesn’t’ have anything to do with valuations. But it does have to do with expectations. And whether you like it or not, those tend to be self-fulfilling. So if people believe 5,000 matters, then it matters.”

Murray, by the way, is one of the few traders we’ve worked with who DOES understand the fundamental picture. In fact, he’s a bit of an Austrian at heart, or at least considers that perspective in his “big picture view.” That informs all of his trading. And he’s actually a bit in the deflationist camp right now, although when we looked at his update last week for Slipstream Trader he was doing just fine – despite being wary of a big drop in the market.

Rio Tinto isn’t wary at all. Rio’s Andrew Harding, who heads its copper business, said that copper prices looked good based on tight supply. “From a supply point of view, there are just not a lot of new stories out there…It would be hard to imagine what would cause a collapse in the copper price.” Hubris alert.

We could imagine it easily enough. All you have to do is go back a few years. It’s not a feat of imagination at all. Just memory. Copper sold for a shade under US$9,000 a tonne in July of 2008. By December, it had fallen to $2,812 – a previously unimaginable decline.

As our friend Rick Rule says, in the resource markets, you’re either a victim or you’re a contrarian. So what is it right now? Diggers and Drillers editor Alex Cowie probably has the hardest job at our shop at the moment. He has to pick resource winners while being aware that the market may be like a few years ago, when forecasts and expectations became wildly unrealistic.

Alex is doing just fine. In fact he recommended a copper stock a few months ago which is travelling nicely. We remember being skeptical at the time. But the question is whether it’s like 2007 – where you have another year of euphoria in front of you. Or 2008, where you may have another few months.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Comments

  1. Key psychological levels, much like religion, cease to be true if enough people stop believing in it.

    Unpopular Truth
    April 8, 2010
    Reply
  2. What do you mean Unpopular truth? Religion is always true whether people beleive in it or not

    Reply

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